Chapter 7
Self-Employment
Accounting Methods
Cash method
Taxpayers report income when they actually or constructively receive it.
Exceptions: Rent, insurance
Accrual method
Income includes amounts earned or accrued but not received; expenses include liabilities incurred but not paid.
Schedule C
" Income and expenses from trade or business
o File a separate Schedule C for each business that you have
" Income (Gross Receipts)
o Documentation - cash register tape, deposit slips, bank statements, accounting records, 1099-MISC
Examples of Self-Employment Income
" Sales of product
" Consulting fees
" Director's fees
" Fees earned by a clergy member or a Christian Science practitioner
" Earnings of a registered nurse or licensed practical nurse employed directly by the patient
" General partner's distributive share of partnership income and loss (Schedule E)
" Guaranteed payments to a limited partner (Schedule E)
" Fees charged by a child-care provider, unless services are provided in the parent's home
" Fees earned by a professional executor
" Commissions earned by a real estate agent
" Earnings of a newspaper vendor over age 17
" Royalties received by an author
Examples of Income Other Than Self-Employment
" Dividends, unless a dealer in securities
" Earnings of a corporate employee, even if a 100% shareholder of the corporation
" Fees earned from an occasional lecture
" Gains and losses on the sale of property
" Interest
" Limited partner's share of partnership ordinary income or loss
Examples of Income Other Than Self-Employment
" Real estate rentals, unless a real estate dealer
" Payment to a registered nurse or licensed nurse by an agency, doctor, or hospital
" S corporation shareholder's share of corporation's ordinary income or loss
" Wages and tips received for services performed as an employee
" Wages of a newspaper carrier or vendors under age 18
Ordinary and Necessary Trade or Business Expenses
" What is ordinary and necessary?
o Customary
o Appropriate and helpful
" What is reasonable?
" Non-Deductible Expenses:
o Illegal bribes, kickbacks, and other payments
o Payments for certain lobbying and political expenses
o Payments for fines and penalties
" Documentation - receipts, cancelled checks, contracts, logs, calendars
Deductible Business Expenses
" Accounting and bookkeeping fees, allocate some to Schedule A
" Advertising, not lobbying
" Bad debts - accrual basis - Actual (Direct write-off method)
" Bank service charges
" Commissions and fees
" Contract labor costs
" Cost of goods sold - Page 2 of Schedule C
" Depletion and depreciation - Form 4562
" Education - not for a new profession
" Employee achievement awards
" Employee benefit programs - insurance for employees +
" Employees' pension and profit-sharing plans
" Employment agency fees
" Gifts - limited, no charitable deductions on Schedule C
" Insurance, license fees, and taxes
" Interest on business loans
" Legal and professional services
" Maintenance and repairs
" Meals and Entertainment - limited to 50%
" Office supplies and expense
" Rent - Capital leases
" Salaries and wages
" Supplies
" Professional dues and subscriptions
" Tax planning and preparation fees - allocate some to Schedule A
" Telephone and utilities
" Transportation, including car and truck expenses - actual or standard
" Travel away from home
" Other
Deductible Car and Truck Expenses
" Standard Mileage or Actual
" Garage rent, parking, and tolls
" Gasoline, oil, and lubrication
" Insurance, licenses, and auto club dues
" Lease payments
" Maintenance and repairs
" Property taxes - DMV fees
" Tires and batteries
" Washing and polishing
" Interest
Deductible Travel Expenses
" Air, rail, and bus transportation
" Baggage charges
" Dry cleaning and laundry
" Lodging
" Meals and entertainment (subject to limitations)
" Car expenses, including car rental
" Other expenses related to travel
" Telephone and fax costs
" Tips related to travel
" Transportation to and from the airport and the hotel, from one customer to another, or from one place of business to another
Business Use of Your Home
" Calculating the Deduction
o Reported on Form 8829, then transferred to Schedule C, Line 30
o Business use is exclusive, regular and for the taxpayer's trade or business (self-employed) or for the convenience of the employer (Schedule A)
" Meet with clients/customers
" Use for administrative or management activities if no other location is available
o What can you deduct?
" Direct costs
Those items directly affecting the business portion
" Indirect costs - require allocation based on square footage
" Deduction Limit
o Gross income first reduced by business expenses, then by
o Business use portions of insurance, utilities, and depreciation
o Can't create a loss with home office expenses
o Any excess deduction will be carried forward to next year
Requirements for Using Schedule C-EZ
" Cash method of accounting is used
" Only one business operated as a sole proprietor
" No employees during the year
" No inventory at any time during the year
" Business expenses of $5,000 or less
" No net loss from the business
" No unallowed prior year passive activity loss from the business
" No deduction for business use of the home
" Not required to file Form 4562 (depreciation) for the business
Self-Employment Tax
" Self-employed taxpayers
o pay income & self-employment tax with their (quarterly) estimated payments;
o must pay both the employer and employee halves of FICA (12.4% for OASDI and 2.9% for HI); and
o deduct one-half of the self-employment tax from gross income (for AGI).
Self-Employment Net Profit - Schedule SE
" Net profit (or loss) reported on Schedule C (line 31) or net profit reported on Schedule C-EZ (line 3)
" Net profit (or loss) from farming reported on Schedule F
" The individual's distributive share of the ordinary net income (or loss) from a partnership or joint venture
" Example - Bonanza Ice Cream Parlor/Tubman
o Short form - Sch C income
o Long form - Sch C income + Social Security Wages of $95,000
Retirement Plans for Sole Proprietors
" Must cover the employer & employees
" Employer contributions reported on page 1 of Form 1040 (not on Schedule C) as an adjustment to income.
" Employee contributions paid by the employer are deducted on Schedule C.
" Keogh plans - Defined Benefit & Defined Contribution
" Simplified Employer Pension (SEP) plans
" Savings Incentive Match Plan for Employees (SIMPLE)
" 401(k) plans
" All plans must be in writing
" Keoghs, Simples and 401(k) must be set up prior to the end of the year
" Contributions must be paid by due date of return including extension
o Employee contributions to 401(k) should be paid monthly
" See handout
" SEP Calculation Example - Tubman
End of Chapter 7
